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Elevated government debt levels in advanced economies have risen rapidly as sovereigns absorbed private-sector losses and cyclical deficits blew up in the Global Financial Crisis and subsequent slump. A rush to fiscal austerity followed but its justifications and impacts have been heavily debated. Research on the effects of austerity on macroeconomic aggregates remains unsettled, mired by the difficulty of identifying multipliers from observational data. This paper reconciles seemingly disparate estimates of multipliers within a unified framework. We do this by first evaluating the validity of common identification assumptions used by the literature and find that they are largely violated in the data. Next, we use new propensity score methods for time-series data with local projections to quantify how contractionary austerity really is, especially in economies operating below potential. We find that the adverse effects of austerity may have been understated.Read more...

Abstract:

Elevated government debt levels in advanced economies have risen rapidly as sovereigns absorbed private-sector losses and cyclical deficits blew up in the Global Financial Crisis and subsequent slump. A rush to fiscal austerity followed but its justifications and impacts have been heavily debated. Research on the effects of austerity on macroeconomic aggregates remains unsettled, mired by the difficulty of identifying multipliers from observational data. This paper reconciles seemingly disparate estimates of multipliers within a unified framework. We do this by first evaluating the validity of common identification assumptions used by the literature and find that they are largely violated in the data. Next, we use new propensity score methods for time-series data with local projections to quantify how contractionary austerity really is, especially in economies operating below potential. We find that the adverse effects of austerity may have been understated.

The time for austerity : estimating the average treatment effect of fiscal policy/Oscar Jorda; Alan M Taylor; National Bureau of Economic Research.; Cambridge, Mass. : National Bureau of Economic Research, 2013.